The Wall Street Journal (subscription required) has obtained a draft version of the SEC's report on bond-rating firms and their role in the credit bubble, and some of the stuff is pretty scary.

In one e-mail, a staffer at Standard & Poor's, which is own by McGraw-Hill (NYSE: MHP) told another that "we rate every deal," and that "it could be structured by cows and we would rate it."

Another wrote that "rating agencies continue to create" an "even bigger monster -- the CDO market. Let's hope we are all wealthy and retired by the time this house of cards falters. ;O)"

Yes -- complete with the smiley face. If this seems reminiscent of disgraced analyst Henry Blodget's e-mails bashing stocks he was publicly pumping during the dot-com bubble, that's because it's exactly the same. The lesson here, once again, is this: e-mails ever really get deleted permanently and, if you're being shady or doing something unethical, make a phone call, talk with the person in a dark alley, or send them a letter that they can promptly discard. Don't send an e-mail!

Of course, S&P's investment-grade ratings on CDOs stuffed with dodgy loans turned out to be wildly optimistic, and the house of cards has done more than falter -- it's brought down Bear Stearns and wreaked havoc on the economy.

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Tom Taulli is the author of various books, including The Complete M&A Handbook and The Edgar Online Guide to Decoding Financial Statements. He also operates MergerBook.com.

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MOST NOTEWORTHY:

• Jefferies initiated McGraw-Hill (NYSE: MHP) with a Buy rating and $49 target. The firm believes the downturn in credit markets has already been fully priced into shares and expects the stock to gain momentum throughout 2008 in anticipation of liquidity returning to credit markets.
  
• RBC Capital initiated Curis (NASDAQ: CRIS) with an Outperform rating and $2.50 target based on the company's partnership with Genentech (NYSE: DNA) and potential upside from its pipeline.
  
• Merriman started Azure Dynamics (OTC: AZDDF) with a Buy rating. The firm believes the company's focus is where customers see the most benefit from a medium-duty hybrid or market-appropriate solutions and finds the stock attractively valued.

• Dr. Pepper Snapple (NYSE: DPS) was assumed with a Market Perform rating at Wachovia.
  
• Morgan Stanley started Chiquita Brands (NYSE: CQB) with an Equal Weight rating.
  
• Credit Suisse initiated Iron Mountain (NYSE: IRM) with a Neutral rating and $34 target.

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MOST NOTEWORTHY:

• Keefe Bruyette upgraded shares of IberiaBank (NASDAQ: IBKC) to Market Perform from Underperform after the company announced that Pulaski has assumed the insured deposits of ANB Financial of Bentonville, Arkansas.
  
• KeyBanc upgraded Dynamic Materials (NASDAQ: BOOM) to Buy from Hold citing stability in base business, valuation, and the added benefit associated with a European competitor being acquired.
  
• Cowen raised Barr Pharma (NYSE: BRL) to Outperform from Neutral citing the recent pullback.

• Goldman added McGraw-Hill (NASDAQ: MHP) to its Conviction Buy List.
  
• RBC Capital raised RadioShack (NYSE: RSH) to Sector Perform from Underperform.
  
• Sirius Satellite (NASDAQ: SIRI) was upgraded at Merrill Lynch to Neutral from Sell.

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Merrill Lynch upgraded Sirius (NASDAQ: SIRI) to "neutral" from "sell" according to Briefing.com. The news service also reports that Citigroup downgraded EDS (NYSE: EDS) from "outperform" from "market perform".

Goldman Sachs downgraded ITV to "sell" from "neutral," according to MarketWatch.

McGraw-Hill (NYSE: MHP) and Moody's (NYSE: MCO) were both started as "buy" in new coverage at Jefferies, according to 24/7 Wall St.

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CNNMoney reports that McGraw-Hill Co.'s (NYSE: MHP) Standard & Poor's (S&P) forecasts the possibility of a $1 trillion bailout of Federal National Mortgage (NYSE: FNM) and Federal Home Loan Mortgage (NYSE: FRE) -- government sponsored purchasers of pools of loans which package them into securities. Specifically, S&P forecasts that a bailout of these two -- known as Fannie Mae and Freddie Mac -- would cost -- in a worst case scenario -- between $420 billion and $1.1 trillion of taxpayer's money. This would represent several times the $250 billion Savings & Loan bailout by the first President Bush.

It's a bit ironic for S&P to be issuing this report. After all, it was among the ratings agencies that contributed to the problem in the first place. As I posted last August, the ratings agencies competed for enormous fees from investment banks to put their AAA ratings on issues of mortgage-backed securities (MBS). Those AAA ratings caused naive MBS buyers to skip the kind of detailed analysis of their purchases that might have stopped the flow of dumb money into the MBS bubble that is now putting Fannie and Freddie at risk.

How did S&P arrive at this scary conclusion? Both companies are forecast to report more losses this year due to declining home prices and rising mortgage defaults. And according to Yale professor, Robert Schiller, "The real fundamental problem is real estate prices have been falling and they might fall substantially more. The Office of Federal Housing Enterprise Oversight (OFHEO) and Fannie and Freddie never considered the possibility of a massive real estate correction."

Moreover, the vast majority of mortgages were backed by Freddie or Fannie -- at the end of January, 82% of all mortgages in the U.S. were backed by one of the firms, up from only 46% in the second quarter of 2007. That means if we're in a recession and many people start losing their jobs, more and more of them will stop paying their mortgages. This could bring that worst case scenario closer to reality and trigger the S&P forecast bailout.

It remains to be seen how much money the U.S. can afford to shovel into a credit crunch bailout. To paraphrase former Senate Minority Leader, Everett Dirksen's famous phrase [he never actually said it]: a trillion here and a trillion there and pretty soon you're talking about real money.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.

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Bloomberg News reports that McGraw Hill Co.'s (NYSE: MHP) Standard & Poor's (S&P) reportedly called the bottom of the subprime meltdown after estimating its toll at $285 billion, up from a previous forecast of $265 billion. It raised its estimate because of increased loss assumptions for collateralized debt obligations (CDOs). And it claims that, "The bulk of writedowns may have already been taken."

Maybe, maybe not. S&P is not exactly objective about this. It was among the ratings agencies that caused the problem in the first place. How so? As I posted, back when the $6.1 trillion MBS market was booming, investment banks would pit rating agencies against each other to see which one would give a AAA rating to the toxic waste they were brewing. If S&P won the contest, it would get the lucrative fee from the investment bank.

S&P and its peers made good money by lending their credibility to the firms they were supposed to rate objectively in exchange for those fees. And when the MBS market began to collapse, the ratings agencies suddenly realized that there was no more new ratings business to be had. So they had to go plan B -- trying to salvage their reputations by downgrading the MBSs that they had previously blessed. This reinforced the collapse of the MBS market.

Now I am wondering whether S&P's claim that the end is near has any substance behind it. Does it know the payment status of each of the, say, 14,000 mortgages within each of the MBSs being held by institutions around the world? Does it understand the specific valuation methods that each MBS holder is using and determined that these methods will pass muster with their auditors?

And perhaps most importantly, has it taken into account the effect that a fire sale of MBSs will have on their values? This comes to mind in light of the default of Carlyle Capital, about which I posted here. If banks take possession of these MBSs to try to minimize their losses, won't more and more of these MBSs be thrown on the market? And won't this further depress prices?

I would like to believe S&P. But in my mind, its credibility is suspect. And even if it had been perfectly objective throughout all this, MBSs are so complex that I don't think anybody can really say how bad the situation is likely to become.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.

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MAJOR PAPERS:

• The active ingredient in Baxter International Inc's (NYSE: BAX) generic version of the anticlotting drug heparin, under investigation for four deaths and hundreds of bad reactions, was made in China, the Wall Street Journal reported.
• Structured investment vehicles that provide short term debt to fund the purchases of municipal bonds and student loans are under increasing pressure, according to the Wall Street Journal's "Heard on the Street". Citigroup Incorporated (NYSE: C), JP Morgan Chase & Co (NYSE: JPM) and Merrill Lynch & Co Inc (NYSE: MER) are among the banks that could be affected.

• The New York Times reported that Hewlett-Packard Company (NYSE: HPQ) has settled with The New York Times Company (NYSE: NYT) and McGraw Hill Companies Incorporated's (NYSE: MHP) BusinessWeek journalists related to a spying scandal that stemmed from obtaining telephone records. The involved parties did not disclose the amount of the settlement.

• Mike Zafirovski, CEO of Nortel Networks Corporation (NYSE: NT), said the company would examine possible opportunities to be taken over "when they arise." Mr. Zafirovski did not comment on rumors of a Motorola Inc (NYSE: MOT) merger, Reuters reported.

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The New York Times reports that McGraw-Hill Co.'s (NYSE: MHP) Standard & Poor's (S&P) has downgraded bond insurer ACA Financial Guaranty Corporation from A to CCC, a sub-investment grade. S&P is saying that ACA's financial guarantee is worthless and thus bond holders must write-down the assets ACA insured.

As of September, ACA insured $7 billion in municipal and $43 billion in corporate debt. S&P's downgrade could cost Merrill Lynch & Co. (NYSE: MER) $3 billion and Canadian Imperial Bank of Commerce (NYSE: CM) estimates it will take a $2 billion write-down.

A few decades from now when economic historians look back on the current financial market implosion, there will be books written about the role that ratings agencies played in blowing up the bubble and then bursting it. That's because the ratings agencies competed with each other to offer the highest ratings to bundles of loans such as Collateralized Debt Obligations (CDOs). Now that this market has collapsed, the ratings agencies see no profit in rating new CDOs so they're trying to salvage their reputations by bending over backwards to downgrade those same debt instruments.

The delisted ACA Capital Holdings needs to cough up $1.7 billion by January 18, 2008 because it contracted to do that if its rating fell below A. This is also a problem for The Bear Stearns Companies (NYSE: BSC) -- about which I posted earlier today -- which owns 29% of ACA. As the ratings agencies continue downgrading debt issues and their insurers, the true costs of the current system will suddenly become apparent.

As a teacher, I can imagine the mess that would result if my students competed to see who could pay me the most money to get an A in my class. But that's the relationship between the ratings agencies and the banks. As I posted in August, the ratings agencies competed with each other to offer the highest ratings to the securities the investment banks issued. The ratings agencies willing to give the highest rating won the bidding.

That little wrinkle in the system will need to be fixed in order to restore confidence in our credit markets. In the meantime, those ratings downgrades could us trillions. The interesting question is whether all the value created while the ratings agencies were blowing up the bubble will be completely wiped out by what they are now destroying.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.

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For 25 years, Steven Halpern, editor of TheStockAdvisors.com, has surveyed the leading financial newsletter advisors asking for their favorite stocks for the coming year. This article is one of 100+ ideas in the Best Stocks for 2008 report.

"McGraw-Hill (NYSE: MHP) is my top conservative pick for 2008," says Nathan Slaughter, editor of Half-Priced Stocks. "If you want to beat the market in 2008, then you might start with the one company that actually owns the market, or at least the S&P 500 Index; McGraw holds the keys to the widely used stock barometer, as well as other benchmarks from the ubiquitous Standard & Poor's family.

"From futures contracts to ETFs, there is a staggering $5 trillion of investable assets linked to these indices -- which generate piles of recurring royalty and licensing revenues.

"Elsewhere, the firm is also a leading provider of textbooks and other supplemental learning materials. There are roughly 55 million students enrolled in grades K-12, and state governments currently spend more than $8,500 per student each year -- a total that is forecast to hit $11,000 within the next seven years.

"Finally, the company is also a dominant player in the credit-ratings business. Thanks to government-regulated barriers to entry, McGraw-Hill handles about 92% of all debt volume issued in the US and has issued ratings on $34 trillion in outstanding debt in over 100 countries worldwide.

"Over the past few months, the deterioration of mortgage-backed securities and other related fears have battered financial stocks like McGraw-Hill almost indiscriminately. However, the big picture outlook remains compelling as debt issuance in overseas markets swelled around 30% last year.

"Once the credit markets stabilize, McGraw-Hill will go on converting its rich abundance of competitive advantages into a mountain of cash flows -- most of which is funneled into the pockets of shareholders through dividends and share repurchases.

"Meanwhile, the stock, which typically garners a premium multiple, is now trading at an attractive discount to the broader market for the first time in over four years."

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Bloomberg News reports that Connecticut's attorney general has subpoenaed McGraw Hill (NYSE: MHP)'s Standard & Poor's related to an investigation into credit rating.

The legal question is whether S&P issued overly rosy credit ratings on subprime mortgage-backed securities (MBSs) that later lost more than half their value. S&P and its peers were competing for the lucrative ratings fees paid by the investment banks that underwrote the MBSs. And it has been alleged that the winning firms offered the highest ratings.

If the MBSs were indeed the financial equivalent of toxic waste -- then the AAA ratings that S&P and its peers awarded to the MBSs could be thought of as golden wrapping paper. This gold wrap was particularly useful to the investment banks when they visited MBS customers in Europe and Australia.

Rather than get into the details of what was inside the gold-wrapped boxes, these customers simply relied on the assurances of the MBS sales people that the "investment" had been blessed by S&P. No need to dirty themselves with unwrapping the box and exposing the toxic waste within.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned in this post.

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The market rallied strongly on the Fed's announcement today and shot up about 2.5%. The Fed, chaired by Bernanke, cut rates by one half point surprising Wall Street which only expected a quarter point cut.

To excerpt the Feds announcement: "Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time."

The NYSE had volume of 3.6 billion shares with 3,013 shares advancing while 345 declined for a gain of 301.28 points to close at 9,909.03. On the NASDAQ, 2.1 billion shares traded, 2,359 advanced and 657 declined for a gain of 70.00 to 2,651.66.

Almost all stocks trading today were making gains. Some of the bigger gainers of the day include McGraw-Hill (NYSE: MHP) rising $4.29 (9%) to $52.10 on double digit growth expectations. Toll Brothers (NYSE: TOL) rose $1.81 (9%) to $22.72 on interest rate cuts. Sothebys (NYSE: BID) bid higher $3.38 (8%) to $45.82. Kroger Co (NYSE: KR) gained $2.07 (8%) to $29.09 after earnings. CIT Group (NYSE: CIT) rose $2.81 (7%) to $40.83.

Options like the genereral market were active. In options there were 6.4 million puts and 7.1 million calls traded for a put/call open interest ratio of 0.90. CBOE S&P 500 Volatility Index (NASDAQ: $VIX) dropped 6.13 to 20.35 a 23% drop. The VIX is referred to as the markets fear indicator and this is a huge move down as investors everywhere breath a huge sigh of relief. The Financial Sector SPDR ETF (NYSE: XLF) saw heavy volume on the September 34 calls (XLFIH) with over 114,900 options trading. Intel (NASDAQ: INTC) had some heavy volume on the September 25 calls (INQIE) with over 22,200 options trading. Visteon (NYSE: VC) saw heavy volume on the January 7.50 (calls (VCAU) with over 21,500 options trading.

Overall it was a great day on Wall Street as the Fed showed it was serious about financial stability in the market.

Kevin Kersten is an Options Analyst with InvestorsObserver.com. Disclosure note: Mr. Kersten owns and or controls a diversified portfolio of long and short positions that may include holdings in companies he writes about.

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In an environment where investigating things that go wrong is a matter of course, Congress wants to know what went wrong with credit-ratings agencies Moody's (MYSE:MCO) and McGraw-Hill's (NYSE:MHP) Standard & Poor's. Both the SEC and two state attorneys general are examining whether the agencies were acting independent of Wall Street when they issued evaluations of mortgage debt instruments.

There has already been an outcry over lax practices at the firms and McGraw-Hill fired the head of S&P, but a formal look at the companies and their practices could open them up to government sanctions and lead to legal action by those who lost money in the recent downturn in the mortgage business.

The Wall Street Journal (subscription required) reports that: "In recent years, mortgage-backed securities have become a major profit driver at Moody's. It is, of course, harder to make money when all of the ratings are negative. So, the investigation will center on whether clients with more deals, who gave more money to the agencies, got better ratings.

The biggest problem of the probes may not be the legal and financial fate of Moody's and S&P. The question is who will take their places if they become besieged by doubts about their ability to be independent.

Douglas A. McIntyre is a partner at 24/7 Wall st.

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MAJOR PAPERS:

• Amid mounting criticism for its role in the subprime crisis, McGraw Hill Companies Inc (NYSE: MHP) replaced Kathleen Corbet, the president of Standard & Poors, with Deven Sharma, a McGraw Hill senior VP who has been with S&P since the end of last year, reported the Wall Street Journal.
• Barron's Online's "Inside Scoop" column reported that Aeropostale Inc (NYSE: ARO) CFO Michael Cunningham sold $2.1M in stock Monday at an average price of $22.43 per share, according to SEC data.

• Indian IT outsourcing companies Infosys Technologies (NASDAQ: INFY) and Wipro Limited (NYSE: WIT) have reportedly both shown interest in buying out the US-based high-end analytics company MarketRx, which is believed to be worth between $150M and $160M, reported the Economic Times.
• The New York Times reported that General Electric Company's (NYSE: GE) NBC Universal has decided not to renew its contract to sell digital downloads of television shows on Apple Inc's (NASDAQ: AAPL) iTunes online store.
• From BusinessWeek's "Inside Wall Street" column:
  
• Coca-Cola Company (NYSE: KO) is making a comeback, thanks to its huge global distribution edge.
  
• Southern Copper Corporation (NYSE: PCU) is a good copper play, as it is undervalued and ignored, especially considering its 6.21% dividend yield.
  
• Ariad Pharmaceuticals (NASDAQ: ARIA) may be one of the more underappreciated and undervalued biotech stocks around.

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